Executive compensation: Paying for performance

An escrow account could push execs to act for the long term.

Criticism of executive pay and bonuses is rising, especially for those well-heeled execs driving their companies into the ground. But a new study suggests some of the more disparaging comments could be deflected if pay packets and bonuses were deposited into escrow accounts that vest over a two-to-five-year period, with a certain percentage withdrawn as monthly compensation.

The dynamic account, explains Xavier Gabaix, an associate professor of finance at New York University’s Stern School of Business and one of the four authors behind Dynamic Incentive Accounts, overcomes two problems. First, any one year’s compensation takes between two and five years to vest, so managers only benefit if the long-term impact of their decisions is positive.

Second, if a company’s stock plummets, more stocks are included in the escrow account, providing even more incentive to turn the firm around for the long term.

In traditional compensation models, Gabaix and his co-writers have found an increase in firm value must be accompanied by a sufficient hike in pay to keep a manager motivated. For example, a 10% increase in the firm value should be accompanied by a 6% increase in pay.

Gabaix says this new compensation model may need to be accompanied by a base pay increase of about 20%, because of the longer vesting periods. That should be more than enough to smooth any ruffled executive feathers.